We can’t see it or touch it, but we can tax it!

This week we look at House Bill 2416, a bill that applies Hawaii Use Tax to intangible property.

The Use Tax is a tax designed to protect our local businesses. As a consumer, you often have a choice between buying a product from a local seller and one from somewhere out of state. Our general excise tax applies to the local seller, but it might not apply to the foreign one. Therefore, our law says that if you buy from the foreign seller and our GET in fact cannot apply to that sale (usually because the seller does not have a sufficient presence within Hawaii for it to be subject to Hawaii taxes), then you as the buyer will have to pay the same amount of tax to the state directly.

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Most states that have a sales tax also have a use tax, for these reasons. But those states’ taxes generally apply only to sales of goods, not to services or anything else. Our tax applies to other things as well since there was a realization that local sellers of services needed to be protected. Thus, in 2000 and 2001 the laws were amended to bring services and contracting within the scope of the Use Tax. At the time, there was a lot of thought given to the issue because an “import” of services is tougher to see than, say, the import of a new car.

Here, this bill makes taxable an entire new category, and it’s unclear how much thought, if any, was given to the matter. The bill sailed through the legislative process without much in the way of testimony.

Even our Department of Taxation was only able to say that the bill was consistent with its position on custom software (software specially written for a customer). The relevance of the department’s position is debatable because most states, including ours, consider custom software to be services, and we already apply Use Tax to services.

So what, if anything, is the bill trying to tax? License fees, franchise fees, and royalties perhaps? Certainly, a franchise to run a particular branded business in Hawaii or a license to show a particular television show here, for example, are intangible property in Hawaii.

But there is already a Hawaii Supreme Court case, In re Heftel Broadcasting Honolulu, Inc., 57 Haw. 175, 554 P.2d 242 (1976), cert. denied, 429 U.S. 1073 (1977), saying that when that kind of intangible property is created, the franchise owner or license owner has to pay GET, even though the owner may not have any other connection with or physical presence in Hawaii. Now, the way the Use Tax is designed is that if the seller is legally obligated to pay GET, Use Tax is not imposed on the buyer. The buyer won’t know if the seller paid the GET, so liability for Use Tax doesn’t depend on whether the seller actually paid the GET.

So what is really happening? Is the objective to scare people into paying taxes they don’t owe?

Consider what happened to the automobile dealerships in the late 1960s and through the 1970s when they were paying Use Tax, thinking that they were importing automobiles from an unlicensed seller, and the department was getting GET from the manufacturers unknown to the dealerships.

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The story is described in another Hawaii Supreme Court case, In re Aloha Motors, Inc., 69 Haw. 515 750 P.2d 81 (1988), but the court had to give effect to the statute of limitations and held that the dealerships could get a refund of three years of Use Tax, although there had been double payments for a decade. Eventually, special legislation was passed in 1990 (Act 297) to relieve the dealerships from this injustice.

The Use Tax Law is already confusing. Rather than mindlessly adding to the confusion with new taxes that haven’t been tried anywhere else, a comprehensive revamp of the Use Tax Law is needed. At least make it so people have a reasonable chance of understanding the existing law.